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Ins21
Ins21
FUNDAMENTALS OF INSURANCE
SEGMENT A: FUNDAMENTALS OF INSURANCE
CHAPTER 1: Insurance: What is it?
Insurance can be described as follows:
A transfer system, in which one party the insured transfers the chance of
financial loss to another party the insurance company or the insurer.
An insured is a person, a business, or an organization whose property, life, or legal
liability is covered by an insurance policy.
An insurer is an insurance company.
A business, which includes various operations that must be conducted in a way that
generates sufficient income to pay claims and provide a reasonable profit for its
owners.
A contract between the insured and the insurer that states what potential costs of
loss the insured is transferring to the insurer and expresses the insurers promise to
pay for those costs of loss in exchange for a stated payment by the insured.
A Human loss exposure, also called a personal loss exposure, can be defined as any
condition or situation that presents the possibility of a financial loss to an individual or a
family by such causes as death, sickness, injury or un-employment.
In a broader sense, the term personal loss exposure can also be used to include all loss
exposures faced by individuals and families, including property and liability loss
exposures.
Personnel loss exposures, on the other hand, affect businesses.
A personnel loss exposure is the possibility of a financial loss to a business because of the
death, disability, retirement or resignation of key employees.
In order to have an exposure insurable the losses need to be accidental from the standpoint
of the Insured. If an exposure is certain to result in loss or damage then insurance
companies are sure to pay the claim. In such a case, the core principle of insurance is
defeated in total.
Losses That Are Definite and Measurable
To be insurable, a loss should have a definite time and place of occurrence and the amount
of loss must be measurable in pecuniary terms.
If the time and location of a loss cannot be definitely determined and the amount of loss
cannot be measured, writing an insurance policy that defines what claims to pay and how
much to pay in the event of a loss is highly impossible. Also losses are impossible to
predict if they cannot be measured.
Losses That Are Not Catastrophic
Under this topic, the crux is that Insurance business should have a reasonable Geographical
Spread.
Effective pooling of exposure units assumes that the exposure units are independent.
Independence means that a loss suffered by one insured does not affect any other insured or
group of insureds. If exposure units are not independent, a single catastrophe could cause
losses to sizable proportions of Insureds at the same time.
This tendency of insurers not to insure catastrophic losses does not mean that they are not
interested in covering catastrophic perils like flood, inundation, storm, typhoon, tempest,
hurricane, tornado, etc.,
This lay emphasis that there should be a reasonable geographical spread.
Insurance companies seek to cover only loss exposures that are economically feasible to
insure.
Because of this constraint, loss exposures involving small losses as well as those involving
a high probability of loss are generally considered uninsurable.
Writing insurance to cover small losses does not make sense when the expense of
providing the insurance probably exceeds the amount of potential losses.
It also does not make sense to write insurance to cover losses that are almost certain to
occur.
Insurance as a Business
This section provides a brief overview of the business of insurance in regard to the
following:
Types of insurers
Insurance operations
Financial performance of insurers
State insurance regulation
Benefits and costs of insurance
Types of insurers
Private Insurers
Federal Government Insurance Programs
State Government Insurance Programs
Private Insurers
Marketing
Underwriting
Claim handling
Ratemaking
Marketing is the process of identifying customers and selling and delivering a product or
service. Insurance marketing enables insurers to reach potential customers and retain
current ones.
Underwriting is the process by which insurance companies decide which potential
customers to insure and what coverage to offer them.
Claim handling enables insurance companies to determine whether a covered loss has
occurred and if so the amount to be paid for the loss.
The primary sources of income for insurance companies are premiums and investments.
Insurance Companies have investments because they receive premiums before they pay for
losses and expenses.
Insurers need to generate enough revenues from premiums and investments to pay for
losses, meet other expenses and earn a reasonable profit. In addition to loss payments,
insurance companies incur several other types of expenses such claim settling expenses,
viz., surveyors and investigators fees, marketing expenses such as providers commission
and advertisement expenses, payment of taxes, viz., income tax, service tax and other
expenses such as salaries and other overheads.
State Insurance Regulation
A major concern of insurance regulators is that insurers be able to meet their obligations to
insureds. A financially weak insurer may not have the resources necessary to meet its
obligations.
Therefore, insurance regulators closely monitor the financial condition of insurance
companies and take actions necessary to prevent insurer insolvency.
Every state has an insurance department that regulates the insurers doing business in the
state. Almost all aspects of the insurance business are regulated to some degree, but most
insurance regulation deals with rates, insurer solvency, and consumer protection.
State insurance departments regulate insurance rates to protect consumers from excessive
rating and thereby avoid discriminations.
Through solvency surveillance, insurance regulators monitor the financial condition of
insurance companies. Such surveillance enables regulators to work with insurers who have
financial difficulties to keep the insurers in business and maintain their ability to meet
obligations to insureds.
Most states require that insurance companies file their policy forms with the insurance
department so that the department can approve policy language.
States also monitor specific insurance company practices concerning marketing,
underwriting and claims. In addition, state insurance departments investigate complaints
against insurance companies and their representatives and enforce standards regarding their
conduct.
Benefits of Insurance
The very many benefits provided by insurance include :
Reduction of Uncertainty
Because insurance provides financial compensation when covered losses occur, it greatly
reduces the uncertainty created by many loss exposures.
A familys major financial concerns, for instance, would probably center around the
possibility of a breadwinners death or the destruction of a home. When such an
uncertainty is transferred to an insurer, the family practically eliminates these concerns.
Insurance companies have greater certainty than individuals about losses, because the law
of large numbers enables them to predict the number of losses that are likely to occur and
the financial effects of those losses.
Loss Control Activities
Insurance companies often recommend loss control practices that people and business can
implement.
Loss control means taking measures to prevent some losses from occurring or to reduce the
financial consequences of losses that do occur.
Individuals, families, and businesses can use measures such as burglar alarms, smoke
alarms, and deadbolt locks to prevent or reduce losses.
Loss control generally reduces the amount of money insurers must pay in claims.
Efficient Use of Resources
It is a common practice that individuals and business organizations set aside a certain
amount from their income to face future uncertainties. By transferring such uncertainties to
the insurers they can use such reserves for further development by individuals and business
organizations, in exchange for a relatively small premium.
Support for Credit
Before advancing a loan for purchase of any property, lender wants assurance that the
money will be repaid. Insurance makes loans to individuals and businesses possible by
guaranteeing that the lender will be paid if the collateral for the loan (such as house or a
commercial building) is destroyed or damaged by an insured event, thereby reducing the
lenders uncertainty.
Costs of Insurance
The benefits of insurance are not cost-free. Among the costs of insurance are both direct
and indirect costs including the following: -
Increased Losses
Increased Losses can be categorized as follows: Fraudulent Claims
Exaggerated / inflated claims
Claims on account of careless on the part of the insured
Because of insurance, a person might intentionally cause a loss or exaggerate a loss that has
occurred. Many cases of arson or suspected arson involve insurance; some property
owners would rather have the insurance money than the property.
Inflated claims of loss are more common than deliberate losses. For example, an insured
might claim that four items were lost rather than the actual three or that the items were
worth more than their actual value. In liability claims, claimants might exaggerate the
severity of their bodily injury or property damage. In some cases, other parties such as
physicians, lawyers, garage owners, repairers, etc., encourage exaggerated claims.
Some losses might not be deliberately caused, but they might result from carelessness on
the part of the insured.
Increased Lawsuits
Liability insurance is intended to protect people who might be responsible for injury to
someone else or damage to someones property. The number of liability lawsuits has
increased steadily in recent years. One reason for this increase is that liability insurers
often pay large sums of money to persons who have been injured. The increase in lawsuits
in the United States is an unfortunate cost of insurance in our society.
INSURANCE AS A CONTRACT
Insurance is a contract entered into between two parties wherein one party viz., the insurer
promises to pay the other viz., insured for a loss which is indemnifiable as per the policy
terms conditions and exceptions for a return of a consideration viz., premium.
The four basic types of insurance (property, liability, life and health) are generally divided
into two broad categories:
Property Insurance
Fire and allied lines: - Fire and allied lines insurance covers direct damage to or loss of
insured property. The term allied lines refers to insurance against causes of loss usually
written with (allied to) fire insurance, such as windstorm, hail, smoke, explosion,
vandalism, and others. Examples of such policies are a dwelling policy and commercial
property policy.
Business income insurance: - Business income insurance covers the loss of net income or
additional expenses incurred by a business as the result of a covered loss to its property.
For example, when a business has a serious fire, it might have to close until repairs to the
building are made and personal property is replaced because of which there shall be loss of
net income. This insurance pays the insured for such loss of income or additional expenses
that the insured incurs.
Crime Insurance: - Crime Insurance protects the insured against loss to covered property
from various causes of loss such as burglary, robbery, theft and employee dishonesty.
Coverage is provided for money, securities, merchandise and other property under this
insurance. Individuals can avail this cover under Homeowners policy and business
organizations have to go in for separate insurance.
Ocean marine insurance: - This includes hull insurance (which covers ships) and cargo
insurance (which covers the goods transported by ships).
Inland marine insurance covers miscellaneous types of property, such as movable property,
goods in domestic transit, and property used in transportation and communication.
Auto physical damage insurance: - covers loss or damage to specified vehicles owned by
the insured and sometimes covers vehicles borrowed or rented by the insured. Auto
physical damage is generally considered to mean loss or damage to specified vehicles from
collision, fire, theft, or other causes.
Liability Insurance
An insurance policy is a contract between the insured and the insurance company, and
these two are usually the only parties involved in a property loss. Liability insurance,
however, is sometimes called third-party insurance because three parties are involved in
a liability loss; the insured, the insurance company, and the party who is injured or whose
property is damaged by the insured.
Examples of Liability Insurance include the following:
Auto Liability
Commercial general Liability
Personal Liability
Professional Liability
Auto Liability Insurance covers an insureds liability for bodily injury to others and
damage to the property of others resulting from automobile accidents.
Commercial general liability insurance covers businesses for their liability for bodily
injury and property damage. It can also include liability coverage for various other
offenses that might give rise to claims, such as libel, slander, false arrest, and advertising
injury.
Personal liability insurance provides liability coverage to individuals and families for
bodily injury and property damage arising from the insureds personal premises or
activities.
One of the most severe causes of financial loss to a family is the premature death of a
family member, especially the primary wage earner. Life insurance can greatly reduce the
adverse financial consequences of such premature death.
Although there are many variations of life insurance, the three basic types are:
Whole life insurance provides lifetime protection (to age 100). Whole life insurance
policies accrue cash value and have premiums that remain unchanged during insureds
lifetime.
Cash Value is a savings fund that accumulates in a whole life insurance policy and that the
policy holder can access in several ways, including borrowing, purchasing paid-up life
insurance, and surrendering the policy in exchange for the cash value.
Term Insurance is a type of life insurance that provides temporary protection (for a
certain period) with no cash value.
Universal life insurance combines life insurance protection with savings. A universal life
insurance policy is a flexible premium policy that separates the protection, savings and
expense components.
HEALTH INSURANCE
The two types of Health Insurance cover are a) Medical Insurance and b) disability income
insurance.
Medical Insurance covers the cost of medical care, including doctors bill, hospital
charges (including room and board), laboratory charges, and related expenses.
Disability income insurance is a type of health insurance that provides periodic income
payments to an insured who is unable to work because of sickness or injury.
To start with, the following shows the differences amount major types of private insurer
(and Lloyds of London)
Type
Stock Insurer
Purpose
for Legal form
which formed
To earn profit Corporation
for
its
Ownership
Stockholders
Method
of
Operation
The board of
directors,
stockholders
Mutual Insurer
To
provide Corporation
insurance for its
owners
(policyholders)
Policyholders
Reciprocal
insurance
exchange
(interinsurance
exchange)
Lloyds
of
London
To
provide
reciprocity for
subscribers (to
cover
each
others losses)
To earn profit
for
its
individual
investors and its
corporate
investors
Unincorporated
association
Subscribers
(members)
Unincorporated
association
Investors
elected
by
stockholders,
appoints
officers
to
manage
the
company.
The board of
directors,
elected
by
policyholders,
appoints
officers
to
manage
the
company.
Subscribers
choose
an
attorney-in-fact
to operate the
reciprocal.
The Committee
of Lloyds is the
governing body
and
must
approve
all
investors
for
membership.
stockholders supply the capital the insurer needs when it is formed or the additional capital
needed by the insurer to expand its operations. Therefore, one of the primary objectives of
a stock insurance company is returning a profit to its stockholders. The stock form of
ownership also provides financial flexibility for the insurer. For instance, stock insurance
companies can sell additional stocks for its expansions, etc.,
Mutual Insurance Companies
A Mutual Insurance Company is an insurer that is owned by its policyholders and
formed as a corporation for the purpose of providing insurance to its policyholder-owners.
The corporation of a traditional mutual insurer issues no common stock, so it has no
stockholders. Mutual insurance companies are also slowly changing their objective
towards profit making akin to that of Stock Insurance Company.
One traditional difference among mutual insurers involves the insurers right to charge its
insureds an assessment, or additional premium, after the policy has gone into effect.
Known as an assessment mutual insurance company, this type of mutual insurer is less
common today than in the past.
Demutalization is the process by which a mutual insurer, which is owned by its
policyholders, becomes a stock company, which then owned by its stockholders.
Reciprocal Insurance Exchanges
A reciprocal insurance exchange (or an interinsurance exchange) is an unincorporated
association formed to provide insurance coverage to its members. One of the
distinguishing features of a reciprocal is that the subscribers empower an attorney-in-fact to
manage it.
Subscribers (also known as members) are the policyholders of a reciprocal insurance
exchange who agree to insure each other.
Lloyds Association
Two types of Lloyds associations exist Lloyds of London and American Lloyds.
Lloyds of London
Although not technically an insurance company, Lloyds of London is an association that
provides the physical and procedural facilities for its members to write insurance. In other
words, it is a marketplace, similar to a stock exchange, wherein members who are
investors, work to earn a profit from the insurance operations at Lloyds.
Each individual investor of Lloyds belong one or more groups called syndicates, which
conducts insurance operations and analyzes insurance applications for insurance coverage.
The insurance written by each individual Name is backed by his or her entire personal
fortune and assumes liability only for the insurance he or she agrees to write. Lloyds of
London has earned a reputation for accepting applications for very unusual types of
insurance, such as insuring legs of a famous football player against injury. But most of the
insurance written through Lloyds is commercial property and liability insurance.
American Lloyds Associations
American Lloyds associations are much smaller than the Lloyds of London, and most are
domiciled in Texas, with a few in other states. The liability of American Lloyds is limited
to their investment in the Lloyds association. State laws require a minimum number of
underwriters (ten in Texas) for each Lloyds association. American Lloyds are usually
small and operate as a single syndicate under the management of an attorney in fact.
Reinsurance Companies
Reinsurance is a type of insurance in which one insurer transfers some or all of the loss
exposures from policies written for its insureds to another insurer.
In reinsurance, the primary insurer is the insurance company that transfers its loss
exposures to another insurer in a contractual arrangement.
A reinsurer is the insurance company that accepts the loss exposures of the primary
insurer.
Government Insurance Programs
Both the federal government and state governments have developed certain insurance
programs to meet specific insurance needs of the public.
Federal Government Insurance Programs
Some federal government insurance programs serve the public in a manner that only the
government can.
One federal government insurance programs that requires mandatory participation is the
Social Security program.
The Social Security Program
The social security Program formally known as Old Age Survivors Disability and Health
Insurance Program (OASDHI) is a comprehensive program that provides benefit to
millions of Americans, though certain private insurers have similar coverages, they cannot
match the scope of Social Security Program.
The Social Security Administration, a federal government agency, operates the program
and provides four types of benefits:
Losses, which are highly concentrated and are also catastrophic nature, are not preferred
risks by private insurers. Hence, federal government have come out with certain plans like
National Flood Insurance Program and Federal Crop Insurance Program.
State Government Insurance Programs
Among the most common insurance programs provided or operated by state government
insurance programs are:
In addition, all states have some type of insurance guaranty fund designed to pay for
covered loses in the event that an insurer is financially unable to meet its obligations to its
insureds.
State Workers Compensation Insurance Funds
A Monopolistic Fund is a State workers compensation insurance plan that is the only
source of workers compensation insurance allowed in that state.
A Competitive State Fund is a state workers insurance plan that competes with private
insurers to provide workers compensation insurance.
A residual market plan (or shared market plan) is a plan that makes insurance available
to those who cannot obtain coverage because private insurance will not voluntarily provide
coverage such coverage for various reasons.
over which they have no control. Therefore, eligible property includes property in
urban areas as well as property exposed to bush fires, for example.
Insurance Guaranty Fund
A Guaranty Fund is a state fund that provides a system to pay the claims of insolvent
insurers. Generally, the money in guarantee funds comes from assessments collected from
all insurers licensed in the state.
INSURANCE REGULATION
The possibility that an insurance company might not be able to pay legitimate claims to or
for its policyholders is the primary concern of the insurance regulators who monitor the
financial condition and operations of the insurance companies.
Despite the difference among the state regulations, the primary objectives of
insurance regulations are
Rate Regulation
Solvency Surveillance
Consumer Protection
Rate Regulation
Because insurers develop insurance rates that affects most people, the laws of
nearly all states give the state insurance commissioner the power to enforce
regulation of insurance rates
Ratemaking is the process insurer use to calculate the rates that determine the
premium for insurance coverage.
A Rate is the price of insurance for each unit of exposure. The rate is multiplied by
number of exposure units to arrive at the premium.
A Premium is the periodic payment by an insured to an insurance company in
exchange for insurance coverage.
An Actuary analyzes data on past losses and expenses associated with losses and
combining this with other information develops insurance rates. In other words, an
actuary is a person who uses complex mathematical methods and technology to
analyze loss data and other statistics to develop system for determining insurance
rates.
Objectives of Rate Regulation
Rate regulation serves three general objectives:
Prior approval law Rate must be approved by the state insurance department
(commissioner) before they can be used. The commissioner has certain period
typically 30 to 90 days to approve or reject the filing. Some states have deemer
provision (delayed effect clause) that causes the rates to be deemed approved if the
commissioner does not respond to the rate filing within the specified time period.
Flex Rating Law Prior approval is required if the new rates are specified
percentage and above or below previously filed rates.
File and use Law Rates must be filed but do not have to be approved before use.
Use and File Law Rates must be filed within a specified period after they are first
used in the state.
Open Competition (No File Law) Rates do not have to be filed with the state
regulatory authorities. This approach is called open competition, because it permits
insurers to compete with one another by quickly changing rates without review by
the state regulators. Market forces determine rates under this approach.
State Mandated Rates This system requires all insurers to adhere rates established
by the state insurance department for particular type of insurance.
Solvency Surveillance
Solvency is the ability of insurance company to meet its financial obligations as they
become due even those resulting from insured losses that might be claimed several years in
the future.
Solvency surveillance is the process conducted by state insurance regulators of verifying
the solvency of insurance companies and determining whether the financial condition of
insurers enables them to meet their obligations and to remain in business in the long term.
Two major aspects of Solvency Surveillance are Insurance Company Examinations and
Insurance Regulatory Information Systems (IRIS).
Insurance Company Examinations consists of thorough analysis of insurance company
operations and financial conditions. During Examination, a team of state examiners
reviews a wide range of activities including claim, underwriting, marketing and accounting
and financial records.
Licensing Insurers
Licensing Insuring
Most insurance companies must be licensed by the state insurance department before they
are authorized to write insurance policies in that State.
Licensed Insurer (admitted insurer) is one who is authorized by the state insurance
department to sell insurance in that state.
Domestic Insurer is an insurance company that is incorporated in the same state in
which it is writing insurance.
Foreign Insurer is an insurance company licensed to operate in that state but is
incorporated under the laws of another state.
Alien Insurer is an insurance company licensed to undertake business in a State but
incorporated in another country.
It consists of state laws that regulate the practices of insurers in regard to the four areas of
operations, i.e., Sales and Advertising, Underwriting, Rate Making and Claim Handling.
If there be any unfair trade practices, the license of the particular insurance company
involved will be revoked or suspended by the authorities.
Investigating Consumer Complaints
Every State Insurance Department has a consumer complaints division to enforce the
consumer protection objectives of the state insurance department and to help insureds deal
with problems that they have encountered with insurance companies and their
representatives.
Excess and Surplus Line Insurance (E & S)
This consists of insurance coverages usually unavailable in the standard market, that are
written by unlicensed insurers.
The Standard Market collectively refers to insurers who voluntarily offer insurance
coverage at rates designed for customers with average or better than average loss
exposures. Such insurers write the majority of commercial property, liability insurance in
the United States.
Changes in the business practices, arrival of a new technology, might create new loss
exposures not contemplated in traditional insurance policies. These types of exposures are
often covered under Excess and Surplus Line Insurance by non-traditional insurance
markets.
Unlicensed Insurers are those who are not licensed in many states in which they operate
and who exclusive write only Excess and Surplus lines of business.
E & S insurance is usually written by non admitted (un licensed) insurers. These insurers
are not required to file their rates and policy forms with state insurance departments, which
gives them more flexibility than standard insurers. Although, non-admitted insurers are
generally exempted from laws and regulations applicable to licensed insurers, the E & S
market is subject to regulation. More states have surplus lines laws that require that all E &
S business be placed to Excess & Surplus Line broker. The E & S broker is licensed by the
state to transact insurance business through non-admitted insurers. When an insurance
producer seeks insurance with non-admitted insurers he or she must arrange an E & S
broker to handle the transaction.
Sale of Insurance
Investment of Funds
Premium Income is the money an insurer receives from its policyholders in return for the
insurance coverage it provides. When measuring its total premium income for the year, an
insurance company must determine what portion of its written premiums is considered as
earned premium and unearned premium incomes.
Written Premiums are premiums on policies put into affect or written during a given
period.
Earned Premium represents the portion of the written premium that is recognized as
income only as time passes and as the insurance company provides the protection promised
under the insurance policies.
Un Earned Premium is the portion of written premium that applies to the part of the
policy period that has not occurred.
Investment Income An insurance company collects premiums from its policyholders and
pays claim for its policyholders, the insurer handles large amount of money. Insurers
invest available funds to generate additional income particularly during periods of high
interest rates and high returns in the stock market, the income generated by these
investments are Investment Income.
The reasons for investments of its funds are as follows:
compare income and expenses however an insurer must calculate not only its paid losses
but also incurred losses for the period.
Paid Losses All claim payments that an insurer has made in a given period.
Incurred Losses For a particular period equal to sum of paid up losses and changes in
losses reserves (loss reserves at the end of the period minus loss reserves at the beginning
of the period).
Loss Reserves these are the amounts designated by insurance companies to pay claims for
losses that have already occurred but not yet settled. A loss reserve for a particular claim is
the insurers best estimate of the total amount that will pay in the future for the losses that
has already occurred.
Incurred But Not Reported Losses The Losses that are incurred in a particular period but
not reported to the insurance company in the given period.
Loss Expenses Expenses necessitated by the process of investigating insurance claims in
settling term according to the term specified in the insurance policy.
Other Underwriting Expenses In addition to the losses and loss expenses the cost of
providing insurance includes other significant underwriting expenses. The major category
of insurers underwriting expenses is
Acquisition Expenses
General Expenses
Taxes and fees
Acquisition Expenses The expenses associated with acquiring new business are significant
such as payment of commission, brokerage, bonus paid on the sales, profit and other
measures of productivity, etc., Advertising expenses can be significant component of
acquisition expenses for most of the insurers, regardless of whether the advertising is
directed towards the general public or specifically towards insurance producers.
General Expenses The General Expenses include expenses associated with staffing and
maintaining insurance departments such as accounting, legal, research, product
development, customer service, electronic data processing and building maintenance. In
addition insurers must provide office space, telephones and other utility services for
smooth running of the organization.
Taxes and Fees All the insurance companies in the fifty states levy premium taxes usually
between 2 to 4 percent on all premiums generated by the insurers in a particular state. Fees
component include such things as expenditure involved for licensing and participating in
various insurance programs such as Guarantee Funds and Automobile insurance plans.
Investment Expenses An insurers investment department includes staff of professional
investment managers who oversee the company investment program. Investment expenses
include the salaries and all other expenses related to the activities of the investment
department. On their financial statement, insurance companies deduct these expenses
related to the activities of the investment department to show net income.
Gain or Loss from Operations An insurers net underwriting gain or loss is its earned
premium minus its losses and underwriting expenses for the specific period. When an
insurer adds its net investment gain or loss results to its net underwriting gain or loss, the
resulting figure is the overall gain or loss from the operations.
Net Income before tax is its total earned premium and investment income minus its total
losses and other expenses in the corresponding period.
Income Taxes Like other businesses insurance company pay income taxes on the taxable
income.
Net operating income or loss After an insurance company has paid losses and reserved
money to pay additional expenses, losses and income taxes the reminder is net operating
income, which belongs to the owners of the company.
Insurers Solvency
The ability to pay claims in the event of occurrence of losses depends upon financial
condition of the insurer. So an insurance company must remain financially sound to pay
losses. Its assets, liabilities and policyholder surplus measure the financial position of the
insurance company at any particular time.
Assets These are property both tangible and intangible in nature, owned by an entity, in
this case an insurance company. These include money, stocks and bonds, buildings, office
furniture equipment and accounts receivable from agents, brokers and reinsurers.
Admitted Assets are types of property such cash and stocks, that regulators allow insurers
to show as assets on their financial statements. Such assets are easily convertible to cash at
or near propertys market value.
Non Admitted Assets are types of property such as office furniture and equipment, that
insurance regulators do not allow insurers to show assets on financial statements because
these assets cannot readily be converted to cash at or near their market value.
Major types of liabilities found on the financial statements of the insurers
Liabilities are financial obligations or debts owned by a company to other entity, usually
the policy holder in the case of an insurance company. There are two major type of
liabilities found on an insurers financial statement:
Loss Reserve
Unearned Premium Reserve
Loss Reserve is a financial obligation owned by the insurer to estimate final settlement
amount on all claims that have occurred but have not yet been settled.
Unearned Premium Reserve It is a major liability found on the financial statement of the
P & C insurers. It is liability because it represents the insurance premiums prepaid by
insured for services that the insurers have not yet rendered. For example, if insurance
company decides to wind up its operations midway, the unearned premium on the policies
needs to be refunded.
Policyholder Surplus of an insurance company is equal to its total admitted assets minus
its total liabilities. In other words, policyholder surplus measures the difference between
what the company owns and what it owes.
Balance Sheet
Income statements
Balance Sheet is a type of financial statement that shows the companys financial position
at a particular point of time and includes the companys admitted assets, liabilities and
policyholder surplus.
Income Statements is a type of financial statement that shows the companys revenues,
expenses and net income for a particular period, usually one year.
Financial Statement Analysis
Analyzing the relationship of different items that appear on the insurer financial statements
helps determine how well insurance companies are performing. Comparing two items
produces a ratio that highlights a particular aspect of financial performance. Several such
ratios are widely used in the insurance business. These ratios are broadly known as
Profitability Ratio.
Profitability Ratio
Several ratios measure the profitability of an insurance company. These profitability ratios
are as follows:
Loss Ratio
Expense Ratio
Combined Ratio
Investment Income Ratio
Overall operating Ratio
Loss Ratio is calculated by dividing an insurers incurred losses (including loss expenses)
for a given period of time by its earned premium for the same period.
Expense Ratio is calculated by dividing an insurers incurred underwriting expenses for a
given period by its written premiums for the same period.
The agency relationship, which is based on the mutual trust and confidence, empowers the
agent to act on behalf of the principal and imposes significant responsibilities on both the
parties.
Responsibilities of the Agent to the Principal
In an agency relationship, the agents fundamental responsibility is to act on benefit of the
principal. The laws of agency impose five specific duties on all agents:
Loyalty
Obedience
Reasonable Care
Accounting
Relaying Information
Thus from insured point of view, little distinction exists between insurance agent and
insurance company. The Law presumes that knowledge acquired by the agent is the
knowledge acquired by the insurance company. According to the agency law, the fact that
the agent knew about the exposure means that the insurer is presumed to know about it.
Authority of Agents
Insurance agents generally have three types of authorities to transact business on behalf of
the insurers:
Express Authority
Implied Authority
Apparent Authority
Express Authority is the authority that the principal specifically grants to the agent to sell
the insurance companys product or that the agent has the authority to bind coverage upto a
specified limit. Binding authority is generally granted to the agent in the agency contract
and thus is a form of express authority.
Binding Authority is a power to make insurance coverage effective on behalf of the
insurer; binding coverage is usually accomplished by issuing binders.
A Binder, which can be either written or oral, is a temporary contract between the
insurance company and the insured that makes insurance coverage effective.
Implied Authority is the authority that arises from actions of the agent that are in accord
with the accepted custom and that are considered to be within the scope of authority
granted by the principal, eventhough such authority is not expressly granted orally or in
agency contract.
Apparent Authority is the authority based on the Third Partys reasonable belief that an
agent has authority to act on behalf of the Principal.
Does
the
insurer
employ the
producers?
How
are
producers
usually
Compensated?
Does
the
Agency or
Agent own
the
Expiration
List?
What
methods of
sales are
usually
used?
Independent
Agency
System
Exclusive
Agency
System
Usually
No.
The
more than producers
one insurer
are
employed by
the agency
Usually one Usually No.
insurer
or However
group
of some
related
producers
insurers
begin
as
employees.
Direct
Writing
System
Only
the Yes.
producers
employer
Direct
Response
System
Only
the Yes.
producers
employer
Sales
Usually Yes.
commissions
and contingent
commissions
Personal
Contact,
Phone
or
internet.
Sales
Commissions
and Bonus
Personal
contact,
Phone
or
internet
Usually No.
But
the
agency
contract
might
provide for
the agents
right to sell
the list to
the insurer.
Salary, bonus, No.
commissions or
combinations
Salary
No.
Personal
contact,
Phone
or
internet
Mail, Phone
or internet
Compensation of Producers
While some producers receive a salary, commissions provide the primary form of
compensation for producers. Two types of commissions that producers typically earn are
sales commissions and contingent commissions.
Sales Commission (or simply a commission) is a percentage of the premium that insurer
pays to the agency or producer for the new policies sold or existing policies renewed.
The commission compensates the agency not only for making the sale but also for
providing service before and after the sale. Service provided before the sale includes
locating and screening the insurance prospects, conducting a successful sales solicitation,
getting the necessary information to complete an application, preparing a submission to the
insurance company and presenting a proposal to the prospect. To make a sale, an agent
must also evaluate the prospects needs and recommend appropriate coverage for the client
to sell it. After the sale, the agent often handles the paper work that accompanies policy
changes, billing and claim handling among other things. While the policy is getting to be
renewed, the agency must again analyze the coverage needs and consider any changes in
the insurance coverage.
Contingent Commissions
In addition to the commissions based on a percentage of premiums, many agencies receive
a contingent commission referred to as profit sharing. It is a commission that an insurer
pays usually annually to an independent agency that is based on the premium volume and
profitability level of the agency business with that insurer.
Marketing Management
An important function of marketing management is monitoring agency sales and
underwriting sales to ensure that both the companys and agencys sales and profit
objectives are met.
Producer Supervision
As insurance selling is a one to one activity that often occurs in the producers office and
insurance companies do supervise their producers by using independent agents typically
known as marketing representatives who visit the independent agents representing the
company. They are employees of the insurer whose role is to visit agents representing the
insurer, to develop and maintain sound marketing relationships with those agents, and to
motivate the agents to produce a satisfactory volume of profitable business to the insurer.
Some states such as California, has separate license for solicitors who work for and are
representatives of agents or brokers, often has office employees, and who have more
limited authority than agents. Generally, solicitors can solicit prospects but cannot bind
insurance coverage. In other states, the solicitors are often called customer service
representatives or customer service agents who must secure an agents license.
Licensed producers are required to adhere to all laws regulating insurance sales in the state
or states in which they conduct insurance business.
Unfair Trade Practices Laws
These are State Laws that specify certain prohibited business practices.
typically prohibit various unfair trade practices such as
These laws
Tie In Sales
It is unfair trade practice for a producer to require that the purchase of insurance be tied to
some other sale or financial arrangement, i.e., a practice referred to as tie in sales.
Rebating
Rebating is offering anything other than the insurance itself to an applicant as an
inducement to buy or maintain insurance.
Selecting insureds
Pricing Coverage
Determining Policy terms and conditions
Monitoring Underwriting Decisions
Selecting Insureds
Insurers must carefully screen applicants to determine which one is desirable to insure. If
insurers do not properly select policyholders and price coverages, some insureds might be
able to purchase insurance at prices that do not adequately reflect their loss exposures. The
underwriting selection process is not limited to the underwriters but also include producers
and underwriting managers. Insurance company receives applications, but not all
applications result in issuance of policies. An insurance company cannot accept all
applicants for two basic reasons:
The insurer can succeed only if he selects applicants who are as a group present
loss exposure that are proportionate to the premiums that will be collected. In other
words, insurers try to avoid adverse selection.
Capacity refers to the amount of business an insurer is able to write usually based on the
comparison of the insurers written premium to the size of the policyholders surplus. An
insurer must have adequate policyholder surplus to be able to increase in the volume of
insurance it writes.
Insurers attempt to protect their available capacity in three primary ways:
Optimizing use of available resources means that an insurance company shall use all its
resources to make a profit from the line of business which it specializes. For instance, an
insurance company will not generally write farm business from applicants who have little
or nil experience in the same because of non availability of expertise towards intricacies of
the business.
Arranging Reinsurance
Reinsurance is a contractual agreement whereby one insurer, the primary insurer, transfers
some or all of the loss exposures from policies written for its insureds to another insurer,
the reinsurer.
If the reinsurance is readily available, insurance company can increase the number of new
policies they write by transferring some of the premiums and loss exposures to the
reinsurers. Thus the availability of reinsurance can affect an insurance companys to write
business.
Pricing Coverage
The Underwriting pricing objective is to charge a premium that is commensurate with the
exposure. Commensurate means showing an appropriate relationship. A premium is
commensurate with the exposure when the appropriate relationship exist between the size
of the premium and exposure assumed by the insurer.
Premium Determination
Rate is a price of insurance charged per exposure unit, and an exposure unit is a measure of
loss potential used in rating insurance. The premium is determined by multiplying the rate
by number of exposure units.
Type of Rates
In determining the appropriate premium to charge for coverage, insurers use either class
rates or individual rates.
Class Rates
They are also called manual rates or rates that apply to all insureds in the same rating
category or rating class. Insureds with similar loss exposure are grouped into similar rating
classes.
Class Rates have traditionally been published in rating manuals books used by
underwriters, raters and producers in pricing individual policies. Many insureds within a
rating class have loss characteristics that might not be fully reflected in Class Rate.
Merit Rating Plans modify class rates to reflect these characteristics. Merit Rating serves
two purposes:
It enables the insurer to fine tune the class rate to reflect certain identifiable
characteristic of a given insured.
It encourages loss control activity by rewarding safety conscious insureds with
lower premium or rate than those who do not participate in loss control.
Individual Rates
Individual Rates are also called Specific rates are used for commercial property insurance
on unique structures. The rate is developed only after detailed inspection of the structure
and its contents. Each Individual Rates reflects characteristics such as building
construction, its occupancy, public and private fire protection and external exposure.
Judgment Rates
It is a type of individual rate is used to develop a premium for a unique exposure for which
there is no established rate. With judgment rating, the underwriter relies heavily on his or
her experience.
Determining Policy Terms and Conditions
Selection and Pricing are intertwined with the third underwriting activity determining
policy terms and conditions. The insurer must decide what type of coverage it will provide
to each applicant and then charge a premium appropriate to that coverage. Insurance
Advisory Organizations develop policy forms using standard insurance wording. These
policy forms are referred as standard forms that contains standardized policy wordings.
Some insurers develop their own standard forms that they use in policies for their insureds.
Monitoring Underwriting Decisions
Underwriters periodically monitor the hazards, loss experience, and other conditions of
specific insureds to determine whether any significant changes have occurred. Since
underwriting decisions involve an assessment of loss potential, hazards and other
conditions must be reviewed periodically.
Facultative Reinsurance
This involves a separate transaction for each reinsurance policy and it is not an automatic
binding between the primary insurer and the reinsurer that is the reinsurer evaluates
individually each policy that is asked to reinsure.
Delegating Underwriting Authority
An underwriting authority is the limit on decisions that an underwriter can make without
receiving approval from someone at a higher level. The amount of authority given to each
underwriter usually reflects the underwriters experience, the job title and responsibilities,
and type of insurance handled. With some insurers underwriting authority is highly
Physical hazards
Moral hazards
Morale (attitudinal) hazards
Legal hazards
Physical Hazards are tangible characteristics of property, persons, or operations that tend
to increase the probable frequency or severity of loss.
Moral Hazards are dishonest tendencies in the character of the insured (or applicant) that
increase the probability of a loss occurring.
Morale Hazards (also known as attitudinal hazards) involve carelessness about, or
indifference to potential loss on the part of an insured or an applicant.
Legal Hazards are characteristics of the legal or regulatory environment that affect an
insurers ability to collect a premium commensurate with the exposure to loss.
Hazards in a legal environment might include court decisions that interpret policy language
in a way unfavorable to insurers.
Evaluating Underwriting Options
In evaluating each application, an underwriter faces three options:
Accept the application without modification
Reject the application
Accept the application with modifications.
And finally implementing the Underwriting Decision.
The third option requires the greatest amount of underwriting creativity. This can happen
by modification of coverage, rates, terms, conditions of the policy, by arranging adequate
reinsurance facility, implementation of loss control measures, etc.,
Monitoring the Underwriting Decision
Monitoring of the Underwriting Decision involves:
Where there is a request for coverage changes underwriter must carefully evaluate
each and every change and should make a decision.
Modifying coverage, rate, terms and conditions as and when need arises.
Finally cancel or rejection of renewal depending upon the experience on the
particular account.
Generally, restrictions of this kind help insurance to serve its purpose of providing
protection for policyholders.
However, such restrictions also limit the speed with which an underwriter can stop
providing coverage for an insured who has become undesirable.
CHAPTER: 6
CLAIMS
Next in the process is to obtain adequate information pertaining to the claim to enable its
processing. A claim representative must verify whether the claim is covered under the
insureds policy. If a question of coverage exists and insurer wishes to investigate, then a
reservation of rights letter might be sent to the insured.
A reservation of rights letter is a notice sent by the insurer to an insured advising that the
insurer is proceeding with investigation of a claim but that the insurer retains its right to
deny coverage later.
A reservation of rights letter serves two purposes:
results in reduction in the claim handling expenses both by the agent and the insurer and it
contributes to more competitively priced product.
Public Adjusters
A public adjuster is a person hired by the insured to represent the insured in handling a
claim. Usually insured hires a public adjuster either because of claim is complex in nature
or because of loss negotiation are not progressing satisfactorily.
Internal Claim Administration
Many organizations have developed self insurance plans to cover part or all of the loss
exposure. This involves handling of the claim through establishing an internal claim
department or by hiring third party administrator.
A Self Insurance Plan is an arrangement in which an organization pays for its losses with
its own resources rather than purchase an insurance. However, organization might choose
to purchase insurance for losses that exceed a certain limit.
Internal Claim Departments
If an organization is large enough, it might establish separate claims department who
possess skills and experience to handle many different types of claims. However, for
certain classes of insurance like Workmen Compensation, Product Liability, etc., such
companies will resort to professionals.
The claim handling procedures can vary widely depending on the type of claim involved.
In case of liability claims it takes years to settle and in case of property claims it might take
few months to settle despite the unique challenges and variations in case to case.
There are three steps that are involved in processing most claims:
Investigation
Valuation
Negotiation and Settlement.
Verifying Coverage
In addition to determining the facts surrounding the loss the claim representative must
determine the coverage provided by the policy will pay any or all claims submitted.
Following are the checklist of questions which forms part of verifying the coverage:
Step 2: Valuation
For a claim representative the valuation of loss can be most difficult aspect of settling
property insurance claims. In order to indemnify the insured according to the policy
provisions, the claim representative must be able to answer two questions:
Actual Cash Value is the replacement cost of the property minus depreciation.
Depreciation is the allowance for physical wear and tear or technological or economic
obsolescence.
Replacement Cost is the cost to repair or replace the property using new material or like
kind and quality with no deduction for depreciation.
Agreed Value is a method of valuing property in which the insurer and the insured agreed
on the value of property at that time of policy is written, and that amount is stated in the
policy declarations and is the amount the insurer will pay in the event of total loss to the
property.
In commercial lines of insurance, in some policies, the term agreed value has a different
meaning and relates to the amount of insurance that the insured must carry to avoid a
penalty for underinsurance.
What is the value of the damaged property?
Once the claim representative has verified coverage and identified the valuation method
specified in the policy, the valuation process began. He must use some guidelines to
determine both replacement cost and actual cash value. Personal property and real property
present different valuation problems.
Personal Property
In case of replacement cost method the claim representative will buy the exact style and
brand of the damaged property if the property is not obsolete. If the party no longer
available, he identifies the closes substitute in style and quality and uses that substitutes
value as replacement cost. For actual cash value however depreciation must be estimated.
Real Property
The replacement of the real property can be usually determined by using three factors:
In case of partially damaged property, the claim representative usually prepares a repair
estimate or obtains repair estimates from one or more contractors. Replacing the property
when a partial loss had occurred involves restoring the property to its previous state as
closely as possible.
The two other factors that can affect insurers cost for property claims:
Subrogation
Salvage rights
Subrogation is an insurers right to recover payment from a negligent third party. When
insurer pays an insured for a loss, the insurer assumes the insureds right to collect damages
from a third party responsible for a loss.
Salvage Rights are the rights of the insurer to recover and sell or otherwise dispose of
insureds property on which the insurer has paid a total loss or a constructive total loss.
Constructive Total Loss exists when a vehicle (or other property) cannot be repaired for
less than its actual cash value minus the anticipated salvage value.
Liability Insurance Claims
Liability Claim handling can be complex for several reasons. In liability claims, the
claimant is a third party who has been injured (bodily injury) or whose property has been
damaged by the insured. While it is not always easy to determine the amount of loss in the
property damage liability claims, the problem becomes even more complex when the loss
involves bodily injury or death.
The following points concentrates on the issue of legal responsibility, which lies at the
heart of the liability claim handling process: -
Step 1: Investigation
After receiving the first report of injury or damage, the claim representative must gather
more detailed information relating to the liability claim. The amount of loss will be
relevant only if the loss is covered under the insureds policy, if the insured is legally
responsible for the loss. The claim representatives initial emphasis must be on
determining how much and why the loss have occurred and whether it appears that the
insured is responsible.
Determining how the loss has occurred and assessing the situation
Verifying Coverage
Step 2: Valuation
When bodily injury is involved, determining the amount of damage often depends on the
medical reports and the opinions of the attending physicians. Properly evaluating this
medical report is critical in determining the amount of damages and is a distinguished
factor in settlement of claims. The evaluation aspect of bodily injury claims requires
experience and skill.
Damage refer to a monetary award that one party is required to pay to another who has
suffered loss or injury for which first party is legally liable.
Legal liability might involve following type of damages:
Compensatory Damage
Punitive Damage
Compensatory Damage includes both special and general damages that are intended to
compensate a victim for harm actually suffered.
Special Damages Specific, out of pocket expenses are known as special damages. In case
of bodily injury claims these damages usually include hospital expenses, Doctor and
miscellaneous medical expenses, ambulance charges, prescriptions and loss to wages for
the time spent away from the job during recovery.
General Damages are compensatory damages awarded for losses such pain and suffering,
that do not have a specific economic value.
Punitive Damages are damages awarded by a court to punish wrong doers who, through
malicious or outrageous actions, cause injury damage to others.
Step 3 Negotiation and Settlement
While the award for damages might result from court decisions, a very large percentage of
liability cases are settled out of court through negotiations between the claim representative
and the claimant or the claimants attorney. If negotiations do not bring about a settlement,
the claimant has option of suing for the alleged damages. The court then decides who is
responsible and determines the value of the injury or damage.
The One essential element of the contract is that agreement must exist between the parties
of the contract. One party must make a legitimate offer and another party must accept the
offer. In other word there must be mutual assent.
To be enforceable, the agreement cannot be the result of duress, coercion, fraud or a
mistake. If either party to the contract can prove any of these circumstances, a court
declare the contract to be void.
Competent Parties
For the contract to be enforceable, all the parties must be legally competent. In other
words, each party must have legal capacity to make agreement binding. Individuals are
generally considered to be contract and able to enter into legally enforceable contracts
unless they are one or more of the following:
Insane
Under the influence of drug or alcohol
Minors
Another aspect of legal capacity involves the fact that, in most states, an insurer must be
licensed to do business in the state.
Legal Purpose
The courts might consider a contract to be illegal if its purpose is against the law or against
public policy.
Insurance contracts must involve a legal subject matter. If the property is illegally owned
or illegally possessed goods then it is a invalid contract. In addition, no insurance contract
will remain valid if the wrongful conduct of the Insured causes the operation of the contract
to violate public policy.
Consideration
Consideration is something of value given by each party to a contract. In insurance,
consideration given by the insured is the payment of the premium. Consideration on part
of the insurer is promise to pay covered losses. Eventhough, someone purchasing
insurance receives only a document containing a promise, that promise has a value because
it is a legal obligation.
Insurance Contracts
A personal contract
A conditional contract
A contract involving the exchange of unequal amounts
A contract of utmost good faith
A contract of adhesion
A contract of indemnity
Personal Contract
The identities of the people insured are extremely relevant to the insurance company,
which has a right to select the insureds with whom it is willing to enter into contractual
agreement. Most insurance policies contain a provision (called assignment) that states that
insurers written permission is required before an insured can transfer a policy to another
party.
Conditional Contract
A conditional contract is a contract in which one more parties must perform only under
certain conditions. Coming to insurance contract, for instance, in the event of a loss,
insurer shall pay the same only if covered under policy conditions and insured has certain
duties as to the loss such as immediate notification, etc.,
Contract Involving the Exchange of Unequal Amounts
Insurance contracts can involve exchange of unequal amounts. For instance, in the event of
a claim, it can be such that the claim amount paid is lesser than the premium collected and
vice versa.
Contract of Indemnity
In a contract of indemnity, the insurer agrees, in the event of covered loss, to pay an
amount directly related to the amount of the loss. Property insurance policies contain a
valuation provision that explains how the value of the insured property is to be established
at the time of loss. Liability insurance policies agree to pay on behalf of the insured
amounts that the insured becomes legally obligated to pay to others.
The principle of indemnity, states that the insured should not be better off financially after
a loss than before. In other words, the insured should not profit from an insurance.
Some insurance contracts are not contracts of indemnity but valued policies.
A valued policy is one in which the insurer pays a stated amount in the event of a specified
loss regardless of the actual value of the loss.
Content of Insurance Policies
An insurance policy specifically describes the coverage it provides. Since no insurance
policy can cover every contingency, the policy must describe its limitations, restrictions,
and exclusions as clearly as possible. The best way to determine the coverages provided by
a particular policy is to examine its provisions, which are generally included in the
following sections of the policy:
Declarations
Definitions
Insuring Agreements
Exclusions
Conditions
Miscellaneous provisions
Declarations
The declaration page (also simply called declarations or dec) of an insurance policy is an
information page that provide specific details about the insured and the subject matter of
the insurance, such as
Definition
Since insurance policy contains technical terms or words that are used for specific purpose.
Most policies define these terms that have specific meanings with regard to the coverages
provided.
Insuring Agreements
An Insurance agreement in an insurance policy is a statement that the insurer will under
certain circumstances, make a payment or provide service.
Exclusions
Exclusions are policy provisions that eliminate coverage for specified exposures.
Reasons for Exclusions
Conditions
Insurance policy contains several conditions relating to the coverage provided. The insured
must generally comply with these conditions if coverage is to apply to a loss.
Miscellaneous Provisions
Insurance policies often contain provisions that do not qualify as one of the policy
components. These miscellaneous provisions sometimes deal with the relationship
between the insured and the insurer, or they might help to establish procedures for carrying
on the terms of the contract.
been paid. The common policy conditions are standard provisions that apply to all CPPs
regardless of the coverage included.
For example, if a business owner wanted to purchase property and liability insurance, the
CPP would include the following documents:
Cancellation
Changes
Duties of the Insured after a loss
Assignment
Subrogation
Cancellation refers to the termination of a policy, by either the insurer or the insured,
during the policy period. The cancellation provision states the procedures that must be
followed when cancellation is initiated by the insured or by the insurer. Generally, when
the policy is cancelled by the insured he shall be eligible for a premium refund on short
period basis and when the insurer cancels a policy; he is eligible for a premium on pro-rata
basis.
Changes
Many policies contain a policy changes provision that states changes to the policy are valid
if the insurer agrees to change in writing.
A liberalization clause, on the contrary, is a policy condition that provides that if a policy
form is broadened at no additional premium, the broadened coverage automatically applies
to all existing policies of the same type.
Duties of the Insured After a Loss
There are certain duties which the Insured has to follow in the event of a loss. The first and
the foremost duty shall involve immediate notification of the claim.
The type of cooperation and the duties required depend on the type of coverage provided.
Other duties shall include providing insurer with all the necessary documents such as bills,
statement of accounts, etc., and assist insurers in speedy processing of claim.
Assignment
Assignment is the transfer of rights or interest in a policy to another party by the insured.
Most policies cannot be assigned without written permission of the insurer.
Chapter 8 Property Loss Exposures and Policy Provisions
Property Loss Exposures
A Property Loss Exposure is any condition or situation that presents the possibility that a
property loss will happen.
The three important aspects of Property Loss Exposures are:
Types of Property
Property is any item with value. One common approach of classifying property is to
distinguish between Real Property and Personal Property.
Real Property consists of land as well as buildings and other structures attached to the
land or embedded in it. The term real estate is commonly used to refer to real property.
Personal Property consists of all tangible or intangible property that is not real property.
Insurance practitioners use categories that relate to the insurance treatment of property,
such as:
Buildings
Personal property (contents) contained in buildings
Money and securities
These categories are listed separately here because they represent types of property for
which specific forms of insurance have been developed.
Buildings
Buildings include more than bricks and mortar and other building materials such as
plumbing, wiring, heating and air conditioning equipment, some basic portable equipment
fire extinguishers, snow shovels, lawn mowers, elevators, specially designed portable
platforms, hoists, tracks for use by window washers, wall to wall carpeting, built in
appliances, or paneling, etc.,
Personal Property (Contents) Contained in Buildings
The contents of a typical home include personal property such as furniture, clothing,
televisions, jewelry, paintings and other personal possessions.
The contents of Commercial Building might include:
For insurance purposes, money and securities are classified separately from other types of
contents because their characteristics present special features / problems.
Motor Vehicles and Trailers
To identify property loss exposures, Motor Vehicles and Trailers are broadly categorized as
under:
In insurance, Auto is a broad term that includes cars, trucks, buses and other motorized
vehicles designed for use on public roads.
Mobile Equipment, which is specifically defined in most commercial insurance policies,
includes many types of land vehicles usually designed for use principally off public roads
including equipment attached to them. Examples include bulldozers, farm machinery and
forklifts.
Recreational Vehicles are vehicles used for ports and recreational activities. Examples
include dune buggies and all-terrain vehicles.
Property in Transit
A great deal of property is transported by truck, but property is also moved in cars, buses,
trains, airplanes and ships. These property in transit are exposed to several losses such as
breakage, damage, leakage, fire, explosion, etc.,
Ships and Their Cargo
Ships and their cargo are exposed to special perils not encountered in other means of
transit. For example, ships that operate along coastal waters can run aground, leaving the
cargo stranded. Moreover ocean cargoes fluctuate in their values according to their
location.
Boilers and Machinery
Many businesses have objects that can be classified as Boilers and Machinery. Steam
Boilers, Domestic Boilers, unfired pressure vessels such as air tanks; refrigerating and air
They are susceptible to explosion or breakdown that can result in serious financial
loss.
They are less likely to have explosions or breakdowns if they are periodically
inspected and properly maintained.
With a named perils policy, for coverage to apply, the insured must prove that the
loss was caused by a covered cause of loss.
With a special form coverage policy, if a loss to covered property occurs, it is
initially assumed that coverage applies. However, coverage may be denied if the
insurer can prove that the loss was caused by an excluded cause of loss.
If the property can be repaired or restored, the reduction in value can be measured by the
cost of the repair or restoration. Property that must be replaced has no remaining worth,
unless some salvageable items can be sold as junk. If an item is lost, is stolen, or otherwise
disappears, its value to the owner is reduced just as though it had been destroyed and
retained no salvage value.
A further reduction in value might occur if repaired property is worth less than it would be
if it had never been damaged.
Property might have a few different values depending on the method by which the value
is determined. The most common valuation measures used in insurance policies are
replacement cost and actual cash value and also Agreed Value.
Lost Income
When property is damaged, income might be lost because the income producing capacity
of the property is reduced or terminated until the property is repaired, restored or replaced.
Determining the amount of business income that might be lost due to a property loss
requires estimating the future level of activity of an organization and doing a what if
analysis. This analysis involves projections of the organizations revenues and expenses in
normal circumstances to determine the amount of income that would be lost in the event of
a property loss that disrupts normal operations. The comparison of projected revenues and
expenses reveals the potential loss of income.
Rental property also poses a similar situation because rental income would be lost, if the
property were damaged and the owner would continue to incur some expenses such as
mortgage payments, taxes, etc.,
Increased Expenses
When a property is damaged, in addition to the declination in value, the owner or the other
user might incur increased expenses in acquiring a temporary substitute or in temporarily
maintaining the property in usable condition.
Property Insurance policies must specify exactly which property loss exposures are covered
that is, the types and locations of property, cause of loss, and financial consequences that
are covered. Policies must also state what parties are covered and how the value of insured
property will be determined.
Covered Property Locations
An insurance policy must carefully specify the property that is covered and where the
property is covered.
Many types of property insurance are designed primarily to cover buildings and personal
property. Stating the location of the property covered poses certain challenges. One
challenge lies in describing precisely what is and is not covered under an insurance policy
that provides building coverage. Another challenge lies in the fact that buildings and
personal property do not necessarily remain at a fixed location. Portions of the building
might be removed from the premises for repair or storage.
Other types of property insurance policies are designed to cover personal property that
often moves from place to place. Floaters are policies that are designed to cover property
that floats or moves fro location to location. Examples of such property are camera, fur,
jewelry, etc.,
Dwellings, Buildings and Other Structures
Dwellings and Other Structures
A typical policy on a dwelling covers the residence premises, which is defined as the
location shown in the policy declarations. This shall also usually include structures
attached to the dwelling and materials and supplies located next to the building used to
construct, alter or repair. The coverage for residence premises does not apply to land.
Structures attached to the dwelling include an attached garage or carport. A
freestanding, detached structure is not part of the dwelling. A separate insuring agreement
for other structures covers such detached items. The need for separate insurance
agreement is that different policy limits (dollar amounts of insurance) apply for dwelling
and other structures.
Personal Property
Although buildings and personal property can be insured in the same policy, they are
treated as separate coverage items. The reason being that an operation of an insured peril
in building can also definitely affect personal property and vice versa.
On the other hand, because personal property can be moved more easily than buildings, it
is exposed to additional perils such as theft. In addition, items such as valuable papers,
securities, accounts, computer programs, fine arts, stamps, give rise to loss exposures that
require special handling.
Dwelling Personal Property
This insurance provides coverage on a worldwide basis. The homeowners insuring
agreement for personal property is a very broad statement of coverage, but such broad
coverage is restricted by a number of exclusions and limitations.
Exclusions eliminate all coverage for excluded property or causes of loss, limitations place
a specific dollar limit on specific property that is covered.
Business Personal Property
Business personal property also includes personal property in the open (or in a vehicle)
within 100 feet of the described premises.
Autos
Autos are generally beyond the scope property insurance policies. Most auto insurance
policies do not cover personal while transported in autos, but some provide a minimal
amount of coverage for personal effects.
Non-owned Properties
Homeowners policies provide coverage for the personal property of others, such as guests
or residence employees, while the property is in the insureds home.
Commercial property policies generally extend a limited amount of coverage to the
personal effects of officers, partners, and employees as well as to the personal property of
others while it is in the care, custody, or control of the insured.
Moveable Property
Dwelling Personal Property insurance provides coverage on a worldwide basis to personal
properties that does not remain at a fixed location.
Business personal property also includes personal property in the open (or in a vehicle)
within 100 feet of the described premises.
Covered Causes of Loss
The various types of crime losses, such as burglary and robbery, are covered by crime
insurance policies as well as by some package policies; special types of policies or
endorsements can cover losses from earthquake and flood
Personal and commercial property insurance policies on buildings and personal property
are available with three different degrees of coverage:
Fire is one of the most serious causes of loss, but not every fire cause loss. A gas fire in a
kitchen oven, an oil fire in a furnace, and a wood fire in a fireplace serve a specific purpose
and cause no loss-unless they blaze out of control. These are called a friendly fire that
stays in its intended place. A hostile fire on the contrary is a fire that leaves its intended
policy.
Some fires ensue from another peril. Lightning might strike a house and set it on fire. It is
standard practice that policies covering fire also cover loss caused by lightning.
These policies also include damage resulting from those conditions accompanying the fire
(such as heat and smoke) and those events that can be linked to the fire in an unbroken
chain of causation (such as collapse resulting from the fire or water damage caused by fire
fighters).
When these conditions occur because of a fire, the fire is considered the proximate cause of
the entire loss. The proximate cause of a loss is the event that sets in motion an
uninterrupted chain of events contributing to the loss.
Windstorm
Windstorm includes hurricanes and tornadoes. Less severe winds can also cause damage.
Water damage due to flood, waves, or spray sometimes accompanies a windstorm. Many
insurance policies cover windstorm damage but not water damage, unless wind causes an
opening to the structure through which water enters.
Hail
Hail consists of ice particles created by freezing atmosphere conditions. Hailstones the size
of marbles, golf balls, or baseballs can cause substantial damages to the insured property.
Light hail can cause damage to standing grain, blossoms on fruit trees.
Aircraft
Aircraft damage occurs when all or part of an airplane or satellite strikes property on the
ground.
Vehicle Damage
Vehicle Damage is a damage done by a motor vehicle to some other kind of property.
Mine subsidence is a cause of loss involving the sinking of ground surface when
underground open spaces, resulting from the extraction of coal or other minerals, are
gradually filled in by rock and earth from above.
Volcanic Action
Volcanic Action is a cause of loss by lava flow, ash, dust, particulate matter, airborne
volcanic blast, or airborne shock waves resulting from a volcanic eruption.
Many property insurance policies used to specifically exclude losses caused by volcanic
eruption. However, since there were no volcanoes considered active in the continental
United States, specific reference to volcanoes began to disappear from insurance policies as
they were revised and simplified.
Broad Form Coverage
This coverage additionally includes:
Breakage of glass
Falling objects
Weight of snow, ice or sleet
Sudden and accidental water damage.
Collapse
Many property insurance policies provide an additional coverage for loss or damage
involving collapse, but only if caused by one or more of the basic or broad causes of losses.
Other covered causes of collapse are hidden decay; hidden damage by insects or vermin;
weight of people or contents; weight of rain that collects on a roof; and use of defective
material or methods in construction, remodeling, or renovation if the collapse occurs during
the construction, remodeling, or renovation.
Crime Perils
Coverage for various crime perils can be included in insurance policies.
Robbery is the taking of property from a person by someone who has caused or
threatened to cause the personal harm.
Theft is a broad term that means any act of stealing; theft includes burglary and
robbery.
E.g.: - A break-in is a burglary; a purse snatching or a holdup is a robbery; and both are
thefts.
Collision
Other than collision (also called comprehensive)
Specified causes of loss (used primarily in commercial auto policies)
Collision covers damage to an insured motor vehicle caused by its impact with another
vehicle or object or by its upset or overturn.
Other than collision (or Comprehensive) is a type of open perils (all-risks) because it
covers any direct and accidental loss that is not caused by collision and is not specifically
excluded such as fire, theft, vandalism, falling objects, flood and various other perils.
Specified causes of loss is a less expensive alternative to comprehensive coverage in
commercial auto policies. This coverage is otherwise called named peril coverage.
Causes of Loss Often Excluded
Reasons for Exclusions
Catastrophe Perils
Some perils that affect a great many people at the same time are generally considered to be
uninsurable by insurance companies, since the resulting losses would be so widespread that
the funds of the entire insurance business might be inadequate to pay all of the claims.
For this reason, almost all property insurance policies exclude coverage for losses from
catastrophes such war and allied perils, nuclear reaction and allied perils, Act of God perils
like earthquake, flood losses, etc.,
Maintenance Perils
Maintenance Perils that are excluded from most policies include:
Such losses are generally uninsurable because they either are certain to occur, over time, or
are avoidable through regular maintenance and care.
Covered Financial Consequences
Property losses can lead to any or all of the following financial consequences:
Business income insurance protects a business from income lost because of a covered
direct loss to its building or personal property.
Covered business income includes the organizations net profit (income minus expenses)
that would have been earned if the insured property had not been damaged.
It also includes the operating expenses that continue while the business is interrupted.
Extra Expenses
These are expenses that reduce the length of a business interruption or enable a business to
continue some operations when the property has been damaged by a covered cause of loss.
Additional Living Expense
This is a coverage in homeowners policies that indemnifies the insured for the additional
expenses incurred following a covered property loss so that the household can maintain its
normal standard of living while the dwelling is uninhabitable.
Parties Covered by Property Insurance
Depending on the policy terms and conditions, property insurance can protect the insured
and sometimes other parties that have an insurable interest in the property and that suffer a
financial loss because covered property is lost, damaged or destroyed.
Generally, policies are written to cover these interests as follows:
The named insured is the policyholder whose name(s) appears on the declarations page of
an insurance policy.
In personal insurance, it also generally includes spouse even if not named in the policy.
However, coverage for the spouse of a named insured depends on the policy definition of
named insured and generally requires that the spouse live in the same household as the
named insured.
The first named insured is the person or organization whose name appears first as the
named insured on a commercial insurance policy and who, depending on the policy
conditions, might be the one responsible for paying premiums and the one who has the
right to receive any return premiums, to cancel the policy, and to receive the notice of
cancellation or renewal.
Secured Lenders
The insurable interest of such lenders is protected when they are listed in the policy.
Mortgagee or Mortgage Holder
Until the loan is paid in full, the lender has an insurable interest in the property because
destruction of the property could cause a financial loss to the lender.
The mortgage clause (or mortgage holders clause) of a property insurance policy protects
the insurable interest of the mortgagee by giving it certain rights, such as the right to be
named on claim drafts for losses to insured property and the right to be notified in the event
of policy cancellation.
The mortgagee has the following rights under the mortgage clause of the building owners
insurance policy: The insurer promises to pay covered claims to both the named insured and the
mortgagee as their interests appear (that is to the extent of each partys insurable
interest).
The insurer promises to notify the mortgagee before any policy cancellation or nonrenewal. The notice enables the mortgagee to replace the policy with other
insurance.
If the insurer cancels the policy and neglects to inform the mortgagee, the
mortgagees interest is still protected, even if the named insured no longer has
coverage.
So that the policy will remain in effect, the mortgagee has the right to pay the
premium to the insurer if the insured fails to pay the premium.
In case of loss, the mortgagee may file a claim if the insured does not.
If a claim is denied because the insured did not comply with the terms of the policy,
the mortgagee may still collect under the policy.
Loss Payee
A loss payee is a lender, named on an insurance policy, who has loaned money on personal
property, such as a car.
A loss payable clause provides that a loss will be paid to both the insured and the loss
payee as their interests appear and gives the loss payee certain rights. However, a loss
payable clause does not extend as many rights to the lender as does a mortgage clause.
Other Parties Whose Property Is Covered
Many property insurance policies provide coverage to parties who are neither named
insureds nor secured lenders and following are few examples:
A homeowners policy can provide coverage for property owned by relatives and
other persons under the age of twenty-one who reside in the named insureds
household.
A homeowners policy can provide coverage for property belonging to guests,
residence employees, and others while it is in the named insureds home.
A commercial property policy providing coverage on the named insureds personal
property can also provide limited coverage for (1) the personal effects of officers,
partners, or employees and (2) personal property of others in the care, custody, or
control of the insured.
A personal auto policy can provide coverage for collision damage if the named
insured borrows a car belonging to somebody else, the car sustains collision
damage and the owner of the borrowed car has no insurance.
In the above examples, the other parties do not enter into the insurance contract with the
insurer, and they have no specific rights to collect under someone elses policy. However,
the named insured can request that the insurer pay claims of this type.
Amounts of Recovery
The amount payable depends on policy provisions in the following categories:
Policy limits
Valuation provisions
Settlement options
Deductibles
Insurance-to-value provisions
Other insurance provisions
Policy limits
When buying property insurance, the applicant usually requests a certain dollar amount of
coverage. If the insurer agrees to provide that amount of coverage, the policy limit is
established and the same is entered into the policy.
It is the maximum amount of money that can be recovered under a policy. It also enables
insured to know whether his property is adequately covered or whether there is any under
insurance.
On the other hand, it shows insurer the maximum amount he has to pay in the event of a
claim under the policy. This enables insurance companies to keep a track of their operation
effectiveness in a given geographical area.
For most property insurance, the premium charged is directly related to the policy limit.
Valuation Provisions
The two most common valuation approaches in property insurance policies are replacement
cost and actual cash value. A third approach, used for certain types of property, involves
agreed value.
Settlement Options
The insurer generally has the option of:
Paying the value (as determined by the valuation provision) of the lost or damaged
property.
Paying the cost to repair or replace the property (if repair or replacement is
possible)
Repairing, rebuilding, or replacing the property with other property of like kind and
quality.
These options for settling property losses can often reduce the insurers cost of settling
claims without diminishing the insureds actual indemnification.
Deductibles
A deductible is a portion of covered loss that is not paid by the insurer. The deductible is
subtracted from the amount the insurer would otherwise be obligated to pay the insured.
Deductibles encourage insured to try to prevent losses. Shifting the cost of small claims to
the insured also enables the insurer to reduce premiums. Handling claims for small
amounts often costs more than the dollar amount of the claim. Thus, deductibles enable
people to purchase coverage for serious losses at a reasonable price without unnecessarily
involving the insurer in small losses.
Insurance-to-Value Provisions
These are provisions in property insurance policies that encourage insureds to purchase an
amount of insurance that is equal to, or close to, the value of the covered property.
Few losses are total. Unless all insureds purchase an amount of insurance close to the full
value of their property, some insureds will pay considerably less for what provides, in most
cases, the same recovery for a loss.
The traditional approach to encouraging insurance to value is to include a coinsurance
provision in the policy. Coinsurance is an insurance-to-value provision in many property
insurance policies. If the property is underinsured, the coinsurance provision reduces the
amount that an insurer will pay for a covered loss.
Chapter 9
Liability Loss Exposures and Policy Provisions
A Liability Loss Exposure presents the possibility of a claim alleging legal responsibility
of a person or business for injury or damage suffered by another party.
A liability loss is a claim for monetary damages because of injury to another party or
damage to another partys property.
Liability claims might result from bodily injury, property damage, libel, slander,
humiliation, defamation, invasion of privacy and similar occurrences.
Legal Liability
Legal liability means that a person or organization is legally responsible, or liable, for
injury or damage suffered by another person or organization.
Sources of Law
The legal system in the United States derives essentially from the following:
Constitutional Law
Constitutional law consists of the Constitution itself and all the decisions of the Supreme
Court that involve the Constitution.
Statutory Law
Statutory law consists of the formal laws, or statues enacted by federal, state, or local
legislative bodies.
Common Law
Common law or case law consists of a body of principles and rules established over time
by courts on case-by-case basis.
Criminal Law Versus Civil Law
Criminal law is the category of law that applies to wrongful acts that society deems so
harmful to the public welfare that government takes the responsibility for prosecuting and
punishing the wrongdoers.
Crimes are punishable by fines, imprisonment, or, in some states, even death.
Civil Law is the category of law that deals with the rights and responsibilities of citizens
with respect to one another. Civil law applies to legal matters not governed by criminal
law.
Civil law protects personal and property rights. If some invades the privacy or property of
another person or harms anothers reputation, the insured person may seek amends in court.
Thus Civil law contributes to the welfare and safety of society.
Criminal and Civil Consequences of the Same Act
Criminal and civil law do not necessarily deal with entirely different matters. A particular
act can often have both criminal and civil law consequences.
Elements of a Liability Loss Exposure
A liability loss exposure involves the possibility of one party becoming legally responsible
for injury or harm to another party.
This section examines the following elements of a liability loss exposure:
The legal basis of a claim by one party against another for damages
The financial consequences that might occur from a liability loss
Contracts
Liability Assumed
Under Contract
Breach of
Warranty
Statues
No-Fault
Auto Laws
Workers
Compensation
Laws
Torts
A tort is a wrongful act, other than a crime or breach of contract, committed by one party
against another.
Tort law is the branch of civil law that deals with civil wrongs other than breaches of
contract. The central concern of tort law is determining responsibility for injury or
damage.
Under tort law, an individual or organization can face a claim for legal liability on the basis
any of the following:
Negligence
Intentional torts
Absolute torts
Types of Torts
Negligence (Failure to act in Intentional Torts (Deliberate Absolute
Liability
a prudent manner)
acts that cause harm)
(Inherently
dangerous
activities)
Elements:
Examples:
Examples:
Duty owed to another
Assault
Owning a wild animal
Breach of that duty
Battery
Blasting operations
Injury or damage
Unbroken chain of events
from breach of duty to
injury or damage
Libel
Slander
False arrest
Invasion of privacy
Negligence
Negligence is failure to act in a manner that is reasonably prudent. Negligence occurs
when a person or organization fails to exercise the appropriate degree of care under given
circumstances.
A liability judgment based on negligence depends on the following four elements:
Intentional Torts
An intentional tort is a deliberate act (other than a breach of contract) that causes harm to
another person. Intentional torts include:
Absolute Liability
Absolute liability (sometimes called strict liability) is legal liability that arises from
inherently dangerous activities or dangerously defective products that result in injury or
harm to another, regardless of how much care was used in the activity. Absolute liability
does not require proof of negligence. (Strict liability is also used to describe the liability
imposed by certain statutes, such as workers compensation laws).
For example, Blasting operations present an exposure to liability for business
organizations.
Contracts
A contract is a legally enforceable agreement between two or more parties. Contract law
enables an injured party to seek recovery because another party has breached a duty
voluntarily accepted in a contract. In such a case, it is the specific contract, rather than law
in general, that the court interprets.
Two areas of contract law important to insurance are liability assumed under a contract and
breach of warranty.
Liability Assumed Under Contract
Parties to a contract sometimes find it convenient for one party to assume the financial
consequences of certain types of liability faced by the other. The party assuming liability
might be closer to the scene, exercise more control over operations, or have the ability to
respond to claims more efficiently.
A hold harmless agreement is a contractual provision that obligates one party to assume
the legal liability of another party. This provision requires that one party to hold harmless
and indemnify the other party against liability arising from the activity (or product) that is
specified in the contract.
Breach of Warranty
Warranties are promises, either written or implied, such as a promise by a seller to a buyer
that a product is fit for a particular purpose.
The law of contracts also governs claims arising from breach of warranty. Contracts for
sales of goods include warranties, or promises made by the seller. The law also implies
certain warranties. The buyer in such contracts does not have to prove negligence on the
part of the seller. The fact that the product does not work shows that the contract was not
fulfilled.
Statutes
Statutory liability is legal liability imposed by a specific statute or law. Statutory liability
exists because of specific statues. Although common law may cover a particular situation,
statutory law may extend, restrict, or clarify the rights of injured parties in that situation or
similar ones. One reason for such legislation is the attempt to ensure adequate
compensation for injuries without lengthy disputes over who is at fault. Prominent
examples of this kind of statutory liability involve no-fault auto laws and workers
compensation laws.
No-Fault Auto Laws
In an effort to reduce the number of lawsuits resulting from auto accidents, some states
have enacted no-fault laws. These laws recognize the inevitability of auto accidents and
restrict or eliminate the right to sue the other party in an accident, except serious cases
defined by the law. Victims with less serious injuries collect their out-of-pocket expenses
from their own insurance companies without the need for expensive legal proceedings.
Workers Compensation Laws
Such a statute eliminates an employees right to sue the employer for most work-related
injuries and also imposes on the employer automatic (strict) liability to pay specified
benefits.
In place of the common law principle of negligence, workers compensation laws create a
system in which injured employees receive benefits specified in these laws. As long as the
injury is work-related, the employer pays the specified benefits regardless of who is at
fault.
Potential Financial Consequences of Liability Loss Exposures
A person must sustain some definite harm for a liability loss to result in a valid claim. To
those who can show that actual harm or injury was suffered, the court may award damages
in addition to the reimbursement of defense costs.
Damage refer to a monetary award that one party is required to pay to another who has
suffered loss or injury for which first party is legally liable.
Legal liability might involve following type of damages:
Compensatory Damage
Punitive Damage
Compensatory Damage includes both special and general damages that are intended to
compensate a victim for harm actually suffered.
Special Damages Specific, out of pocket expenses are known as special damages. In case
of bodily injury claims these damages usually include hospital expenses, Doctor and
miscellaneous medical expenses, ambulance charges, prescriptions and loss to wages for
the time spent away from the job during recovery.
General Damages are compensatory damages awarded for losses such pain and suffering,
that do not have a specific economic value.
Punitive Damages are damages awarded by a court to punish wrong doers who, through
malicious or outrageous actions, cause injury damage to others.
Defense Costs
These costs include not only the fees paid to lawyers but also all the other expenses
associated with defending a liability claim. Such expenses can include investigation
expenses, expert witness fees, the premiums for necessary bonds, and other expenses
incurred to prepare for and conduct a trial.
Automobiles and other conveyances Accidents that result in bodily injury, death
or property damage of another party.
Premises Accidental fall of a third party at the residence or business premises.
Business operations Products of the organization should be defect free and must
solve the purpose otherwise leading to liability due to malfunction.
Completed operations Faulty workman ship can always lead to a liability claim.
Products Manufacture of hazardous products, usage of hazardous raw materials,
hazardous waste arising out of manufacturing process, etc., are typical examples.
Advertising Proper permission should be sought and procedures need to be
followed before releasing an advertisement of a product otherwise it may result in
liability claim.
Pollution Many types of products pollute the environment when they are
discarded. In addition, the manufacture of some products creates contaminants that,
if not disposed of properly, cause environmental impairment or pollution.
Liquor Intoxicated persons threaten themselves as well as others. Providers of
alcohol can be responsible for customers or guests who become intoxicated and
injure someone while drunk.
Professional activities Attorneys, physicians, architects, engineers and other
professionals are considered experts in their field and are expected to perform
accordingly. Errors and Omissions (E &O) are negligent acts (errors) or failures to
act (omissions) committed by a profession in the conduct of business that give rise
to legal liability for damages.
Property insurance claims usually involve only two parties the insurer and the
insured. Liability insurance involve three parties; the insurer, the insured and a
third party the claimant who brings a legal complaint against the insured for
injury or damage allegedly caused by the insured. Although the claimant is not a
party to the insurance contract, he or she is a party to the claim settlement.
In property insurance, insurers pay claims to an insured when covered property is
damaged by a covered cause of loss during the period. In liability insurance, on the
other hand, insurer pays a third party on behalf of an insured against whom a claim
has been made, provided the claim is covered by the policy.
Property insurance policies must clarify which property and causes of loss the
policy covers. In contrast, liability insurance policies must indicate the activities
and types of injury or damage that are covered.
In order to clarify the intent of the insuring agreement, the provisions of a liability
insurance policy must answer the following questions:
The named insured and the named insureds spouse, if the spouse is a resident in
the household.
Relatives of the named insured or spouse, if the relatives reside in the household
Children in the care of the named insured or spouse
Any person or organization legally responsible for animals or watercraft owned by
an insured (except in business situations)
Employees using a covered vehicle, such as a lawn tractor, and other people using a
covered vehicle on an insured location with the named insureds consent.
Commercial liability policies, apart from the named insured, also cover:
Hence the above definitions make it clear that property damage includes both direct losses
and time element (or indirect) losses.
Personal Injury
In insurance, the term personal injury is generally used to mean injury, other than bodily
injury, arising from intentional torts such as libel, slander, or invasion of privacy.
For insurance purposes, intentional torts are usually considered personal injury offenses
and are either excluded from coverage or are specifically covered as a separate coverage.
A few policies define personal injury in a way that includes even bodily injury apart from
the offenses listed above.
However, the more common interpretation allows for separate coverage for bodily injury
and personal injury, in which case personal injury coverage supplements bodily injury
coverage. For example, the commercial general liability policy automatically includes
personal injury coverage under a separate insuring agreement. Coverage for personal
injury liability can be added by endorsement to a homeowners policy.
Advertising Injury
Advertising injury typically includes the following types of offenses:
The definitions of personal injury offenses and advertising injury offenses overlap
somewhat. But this does not result in duplicate coverage. Furthermore, the policy clarifies
that personal injury does not include offenses involving advertising activities and that
advertising injury refers only to offenses committed in the course of advertising activities.
What Costs Are Covered?
Liability insurance policies typically cover two types of costs:
Some policies also cover other costs, such as supplementary payments and medical
payments.
Damages
A person who has suffered bodily injury, property damage, or personal injury for which the
insured is allegedly responsible might make a claim for damages. The claim is often
settled out of court, and the insurer pays the claimant on behalf of the insured.
However, Legal liability might involve following type of damages:
Compensatory Damage
Punitive Damage
Compensatory Damage includes both special and general damages that are intended to
compensate a victim for harm actually suffered.
Special Damages Specific, out of pocket expenses are known as special damages. In case
of bodily injury claims these damages usually include hospital expenses, Doctor and
miscellaneous medical expenses, ambulance charges, prescriptions and loss to wages for
the time spent away from the job during recovery.
General Damages are compensatory damages awarded for losses such pain and suffering,
that do not have a specific economic value.
Punitive Damages are damages awarded by a court to punish wrong doers who, through
malicious or outrageous actions, cause injury damage to others.
Most liability insurance policies do not specifically state whether punitive damages,
intended to punish the insured for some outrageous conduct, are covered. There are certain
State Laws that prohibit insurance coverage for punitive damages.
Defense Costs and Expenses
These costs include not only the fees paid to lawyers but also all the other expenses
associated with defending a liability claim. Such expenses can include investigation
expenses, expert witness fees, the premiums for necessary bonds, and other expenses
incurred to prepare for and conduct a trial.
The insurer is obligated to defend an insured only when the claimant alleges that injury or
damage caused by a covered activity of the insured.
The expenses incurred for the defense, known, as Litigation Expenses are the expenses
incurred for legal defense, such as attorneys fees, expert witness fees, and the cost of legal
research.
Supplementary Payments
In liability policies, supplementary payments are amounts the insurer agrees to pay (in
addition to the liability limits) for items such as premiums on bail bonds and appeal bonds,
loss of the insureds earnings because of attendance at trials, and other reasonable
expenses incurred by the insured at the insurers request.
In other words, these supplementary payments consist of the following:
Prejudgment Interest
Prejudgment Interest is interest that might accrue on damages before a judgment has been
rendered.
Postjudgment Interest
Postjudgment Interest is interest that might accrue on damages after a judgment has been
entered in a court and before the money is paid.
Medical Payments
Medical payments coverage pays necessary medical expenses incurred within a specified
period by a claimant (and in certain policies, by an insured) for a covered injury, regardless
of whether the insured was at fault.
Events that occur during the policy period (in an occurrence basis policy)
Claims made (submitted) during the policy period (in a claims made policy)
The situation becomes more complicated in practice, however. Claims due to injuries that
occur before that retroactive date are not covered even if the claim is made during the
policy period. Occurrence policies also do not cover claims arising from occurrences
before the policys inception date.
Because of period renewals and the possibility that the insured will shift coverage from
insurer to another, maintaining continuous coverage without gaps is perhaps the greatest
difficulty with claims-made coverage.
What Factors Affect the Amount of Claim Payments?
The extent of the insurers payment depends on the following types of policy provisions:
Policy limits
Defense Cost provisions
Other insurance provisions
Policy limits
Limits are expressed in different ways, as follows:
An each person limit is the maximum amount an insurer will pay for injury to any
one person for a covered loss.
An each occurrence limit is the maximum amount an insurer will pay for all
covered losses from a single occurrence, regardless of the number of persons
injured or the number of parties claiming property damage.
An aggregate limit is the maximum amount an insurer will pay for all covered
losses during the covered policy period.
On the other hand, defense costs are usually payable in addition to the policy limits and
policy limits include only payment for damages.
There are certain policies which states that defense costs should be within the overall
policy limit.
Other Insurance Provisions
In cases, where more than one insurance policy exists covering the same property, Other
Insurance provision in a policy will prevent insured from profiting out of a claim from all
the policies covering the property.
Chapter 10
Managing Loss Exposures: Risk Management
Risk Management is the process of making and implementing decisions to deal with loss
exposures. It involves identifying loss exposures and then applying various techniques to
eliminate, control, finance, or transfer those exposures.
Steps involved in Risk Management Process
1. Identifying and analyzing loss exposures
Identifying
Analyzing
Physical inspection
Loss exposure survey
Flowchart
Loss frequency
Loss severity
Accurate measurement of loss frequency is important because the proper treatment of the
loss exposure often depends on how frequently the loss is expected to occur.
Loss Severity
Loss severity is a term that refers to the dollar amount of damages that results or might
result from loss exposures. Loss severity is used to predict how costly future losses are
likely to be.
Properly estimating loss severity is essential in order to treat the exposure to loss. This also
enables on adopting of type of risk management technique.
Most property loss has a finite value and hence it is easy to estimate loss severity of a
property loss than a liability loss.
Step 2: Examining Risk Management Techniques
Risk Management Techniques
Technique
Avoidance
Example
A family decides not to
purchase a boat and
therefore avoids the property
and liability loss exposures
associated
with
boat
ownership.
1. Loss prevention
2. Loss reduction
A business installs a
sprinkler system to reduce
the amount of fire damage
from potential fires.
A business decides not to
purchase collision coverage
for its fleet of vehicles and
sets aside its own funds to
pay for possible collision
losses.
In a lease, a landlord
transfers
the
liability
exposures of a rented
building to the tenant.
Loss Control
Retention
Noninsurance transfer
Insurance
A
family
purchases
homeowners and personal
auto policies from an
insurance company.
Financial management standards typically call for making those choices that promise to
increase profits and/or operating efficiency.
Decisions Based on Informal Guidelines
Do not retain more than you can afford to lose.
Do not retain large exposures to save a little premium.
Do not spend a lot of money for a little protection.
Do not consider insurance for a substitute of loss control.
Step 4: Implementing the Chosen Risk Management Techniques
Implementation of the chosen technique requires that risk manager make decisions
concerning: